WASHINGTON — Ask someone from a California venture capital firm about VC firms created and backed by major companies, and it’s unlikely you’ll get a positive response. That’s a longstanding culture clash of its own, according to Brian Schettler, the head of Boeing’s HorizonX venture fund.
Formed in 2017, HorizonX has so far invested in 25 different companies, all to the tune of $10 million or less. While that’s less than what you get from a big VC firm, it can be a lifeline for companies interested in the aerospace and defense sectors but are struggling to attract early capital to keep the doors open.
Schettler talked to Defense News in January about HorizonX’s strategy and how to attract more VC money to defense-focused companies.
We’ve heard complaints from “traditional” VC players that the prime-backed VC efforts are pains to deal with because the companies are just trying to acquire technology and horde it for themselves. Is that a fair assessment?
It’s not surprising at all that you got some of that feedback. We built HorizonX from the ground up starting about three and a half years ago. And so we were able to be very deliberate of the approach we took, the philosophies we had in the market, and most importantly listening and benchmarking for the best practices and understanding the worst practices that soured the reputation of some corporates in the market — and tried to deliberately not fall in those same traps.
I think our goals align very much with the traditional VCs. It doesn’t necessarily always align with other corporates. My observations of some of the other corporates is they’re driven to essentially gain some sort of unique and differentiated advantage versus their competition, and that usually manifests itself in some form of onerous terms and conditions in the language of the investments, the deal docs, or some other commercial arrangement that is trying to protect exclusivity or future options to buy the whole thing outright; right of first refusals and that sort of thing.
That’s not the approach we take. We’re much more aligned to a traditional VC that wants to see these companies have as much option space as possible. A traditional VC wants these companies to sell to 100 percent of the marketplace because that will be the best financial return for the VC. We want to see our companies sell to 100 percent of the marketplace. They get really frustrated when some corporate comes along and says, “Well, I’m now limiting the exit options of these particular startups or minimizing their market exposure,” because suddenly it’s a lock on one aerospace partner, and so they can’t serve the other 70 percent of the market.
Why did you settle on that approach? Because Boeing, with such big equities in both commercial and defense, could certainly benefit from the acquisition approach.
I think it was really just how we saw us being a good player in the market. I mean, this can’t be a one-sided “It’s Boeing’s way and we’re the only ones that benefit.” Right?
How do you create an ecosystem that’s sustainable around that? Yeah, you may be able to do the other approach for a while and lock up 10 or so companies, but your reputation is going to follow you. Other startups are going to talk to each other, and I just don’t think it’s really sustainable in the long term. We wanted to create something that really had longevity, that really was about relationships and reputation in the market for being good partners, and that would continue on its own and would build support for other entrepreneurs and innovators to start building companies to address aerospace needs.
If it’s viewed as an unattractive market where these corporates are just going to swoop in and either gobble me up early before I reach our full potential or just come with all of these terms that suck the life out of them for the enjoyment of being that entrepreneur, that’s not the ecosystem we want to promote. And so it seemed much more aligned with our long-term goals for how we think innovation and aerospace will be playing out, outside the four walls of major original equipment manufacturers. And this is a way to help promote that globally.
We keep hearing that it’s hard to get venture capital funding for defense-focused companies because of concerns about return on investment and the fact that the defense market is smaller than the commercial market. What are your thoughts on that?
Yeah, it’s very difficult. If it’s a software company, maybe that’s one thing, but if it’s a hardware focus for hard tech, it is capital-intensive, a lot of iterations to mature — it’s a hard sell for a lot of these traditional VCs.
A lot of the VCs don’t have the same level of technical due diligence around focused aerospace technologies that we can bring. So that’s where we’re really trying to build relationships and build syndicates with others, so they can look to us for the best practices we can bring to the company. We’ll look to them for good management discipline, board governance and best practices from the entrepreneurial side that they get from all the investments they do. But hard tech is still a tough pill to swallow for a lot of VCs, we’ve found.
What could be shifted to help that reluctance change?
I think the big one to me is the capitalization piece. Where are other types of money that could come to the table to ensure that these early stage companies just mature enough to the point of being able to address Defense Department needs? Are there other vehicles, like In-Q-Tel and others, that could help deploy capital? And maybe it’s not equity-linked capital. Maybe there are other forms of doing it with notes or grants.
Overall, how do you ensure that it’s not just predicated on a few investors and a few corporates bankrolling the entire long-term supply of these early stage companies? Because I still don’t think it’s feasible. I think there’s so much new technology growing out there on the platform and enabling tech levels that it’s bigger than just institutional investors and corporates can swallow — particularly when there’s competition for those resources with near-term, quick hit investments that can be made in Silicon Valley and beyond.
We found it’s really hard sometimes to attract traditional VCs to the table because they have an opportunity case with their money for other deployment options. [What’s key is] showing the long-term potential, showing the extended trail of revenues. And if you can get your technology on a program of record and that trail can last 30 years, those are the sort of things that are just different worlds from the traditional thinking.
Another issue is that a lot of VC funds have foreign investments, particularly from China. That’s something the Pentagon says it doesn’t want to have to worry about, which would seem to limit the pool of investors.
Not just full-on acquisition but in minority investments as well. By the way, [that’s] absolutely the right thing to scrutinize and I’m totally for it. But it scares off some investors, so now it’s limiting some capital that can go in. Even if it was a noncontroversial investor, or one that would easily get through [review by the Committee on Foreign Investment in the United States], they’re looking at what’s the path of least resistance sometimes. And now maybe it’s a U.K. investor that’s [decides to invest] in a U.K. startup instead of a U.S. startup that that may have defense applications, for example.
But again, right now there’s some shock waves through the industry of, if you’re a foreign investor, how you play with and invest in U.S.-based companies.
Are you seeing some of these foreign investors, including from allied nations, looking at companies and saying: “I’m just not going to get involved in this right now?”
Yeah, I’ve definitely seen some of that, but what worries me more is what you’re actually not seeing. It’s the case of, boy, usually when this type of U.S.-based company was racing around, they’d have 20 people knocking on the door to being the next investor in the company. Fifty percent of them were foreign investors. And now what you’re seeing is those investors aren’t even knocking at the door anymore because, before they’ve even filtered down their pipeline, they’re just prioritizing something with less headache and less resistance that’s maybe in another country or maybe in their own country. And so we’re not even seeing those investors coming to the table in the first place.
Do you see anything shifting in the next five years that could increase support for defense spending in the VC community?
I think it depends on how a couple of things play out. One, if these other group of investors are able to be successful in raising the right funds, I think you’re going to see sufficient capital out there that can start being appropriated to defense-grade startups. And I think industry’s doing more, I think corporates are doing more, and the more success that can be communicated — it’s almost like a reinforcing prophecy a little bit. I think more success begets more success.
I also think it helps, frankly, in what happens in other areas of the economy. As you know, VC is a very cyclical sort of animal. And so times have been really, really good lately for software companies and the new types of unicorns. If the economy started having any kind of slowdown or you saw a traditional VC drying up a little bit, there might be opportunities for redeployment to safer bets, if you will. It might be long-term, it might be slower, but good, methodical, maturing defense programs that have long life cycles may start being a little more attractive.
What factors could hurt investment in the defense sector?
The only kink where I don’t see it growing is just really if investors don’t change, these capital bubbles going into these commercial-grade companies doesn’t change, you get more unicorns and that fuels more investment in chasing the future unicorns.